‘Advantage DARS’ – and Sirius in particular
“100 million US subs” possible, says Clayton
by Chris Forrester
The good news flow for US satellite radio seems unstoppable. Despite on Feb 10 announcing that its net
loss had widened to $190m during the Christmas quarter (against $170m a year ago), XM’s buoyancy is
unlimited. It’s the same at Sirius, and such is the positive news that in January there were rumours that
News Corp might enter the satellite radio market. There are also reports that with their US sales going so
well, that both XM Satellite Radio and rival Sirius are looking at entering the European and possibly
Japanese markets. Additionally, SES Global is reportedly talking about a European satellite radio venture
with Alcatel Space – itself keen to find a buyer for the WorldSpace ground spare craft sitting idle in its
Toulouse facility.
Both XM Satellite Radio and rival Sirius achieved excellent pre-Christmas subs numbers (XM reported
adding 50,000 subs on Christmas Day alone, no doubt with many gifts installed and activated), and even
some recovery on the share prices of both outfits. DARS satellite radio has had a spectacular month or two,
initially with both XM Satellite and Sirius finding their stock prices going through the roof (and falling back a
tad). Sirius was helped by adding Toyota to its motor vehicle distribution list, another step in Sirius’ drive to
level the playing field in its fight with rival DARS player – and first to market - XM Satellite Radio. Toyota
says it is now adding Sirius kit as dealer installed (and after market) installations. Toyota has been installing
XM units up until now, and that relationship will continue on factory-fitted radios beginning in 2006. Toyota
(including Lexus) has a 10.4% share of the US market. XM was helped by its announcement last week that
it had signed up its millionth General Motors subscriber. Sirius was itself further helped by announcing its
snazzy ‘Streamer GT’ hand-held unit.
The rising stock prices for both Sirius and XM also helped propel both outfits before Christmas into the
“NASDAQ 100”. XM also announced that National Car Rental and Alamo were now supplying vehicles with
satellite radio on certain 2005 models. Then, on Dec 15 came news that the FCC would leave satellite radio
alone and outside of its usual terrestrial rules and regulations on indecency, and in effect permitting Howard
Stern to say what he liked on his upcoming [satellite] frequencies.
[Sidebar this]
“I believe that satellite radio hardware sales could be a billion-dollar industry by 2006,”
XM Satellite’s CEO Hugh Panero
[Close box]
Both players used the important 2005 Consumer Electronics Show in Las Vegas to outline a bold agenda for
market expansion, with each introducing new products and programming. XM grew by 1.8 m subs in 2004,
to reach 3.2m by the end of last year, a higher number and speedier achievement than market expectations.
CEO Hugh Panero said he anticipates this year’s growth to be even greater. “We expect XM will end 2005
with 5.5m subscribers, furthering our position as the big dog in satellite radio,” he said, an obvious dig at
competitor Sirius.
But upstart Sirius has also racked up some impressive numbers, with a 300% growth rate in 2004, and
pulled the curtain back on a variety of new receiver systems in expectation of doubling its current subscriber
figure of 1.1m this year. Sirius expects to be helped by ‘shock jock’ Howard Stern’s programming debut in
2006 and Ford’s recent announcement to offer Sirius as a factory installed option on more than 21 models
lines. Ford’s goal is to deliver to Sirius one million new subscribers in the next two years. “We are growing
faster than where the industry is,” said Sirius CEO Mel Karmazin. “We believe we will be even bigger than
most analysts and investors think this industry is going.”
[Box this]
At the CES show in Las Vegas, Sirius said it will be providing television streams in Windows Media format
as part of its offering in 2006. The company has mentioned the possibility of streaming video before,
however the pieces are now in place and the company is expected to begin television broadcasts including
children's programming in 2006. No word yet on whether Howard Stern's show will be telecast, although
chances are it could be.
[close box]
But winning the Ford and – at least – a slice of Toyota’s business is another step forward for Sirius, long the
underdog in the USA’s twin thrust for satellite radio subscribers. The position is best summed up by reports
on the DARS sector from two investment banks within the past few weeks. One, on Sirius (“The Future is
History”) from Bear Stearns, and senior analyst Bob Peck who plainly states that satellite radio is going to be
far more meaningful than just fulfilling an enthusiast’s niche, and is well on its way to becoming ubiquitous.
[sidebar this]
“While we remain bullish on company fundamentals, we believe the recent surge in the stock has taken
Sirius to levels which are difficult to justify using any reasonable valuation framework,''
said Niraj Gupta Dec 8, from Smith Barney. He cut his rating to “sell” from “hold”.
[close box]
Peck suggested that perhaps the market kettle had been boiling a little too vigorously at the end of last year
in terms of Sirius’ share price, given that it was trading at a premium to XM on all three metrics (market
capitalisation, enterprise value, and EV/long-term subscriptions). But with that caution in mind, he also
suggests that investors need only look at the progress over the past few years of satellite pay-TV stocks to
get a flavour of the long-term potential for Sirius (and XM). He suggests, for example, that Charlie Ergen’s
DISH system, like Sirius long the underdog compared to its DBS rival DirecTV, is worth a closer study in
terms of its own early stock market performance. Echostar, when it hit 2m subscribers, at the same time
achieved a major inflection point with investors. On the same basis, Peck says Sirius could have an
enterprise value of $12.5bn by the end of 2005, and implying a value of some $7.50 a share. Since that note
Sirius hit $9, and Peck urged investor caution, but either way the price is not at all bad for a company that
was teetering on the very edge of survival barely 24 months ago (and within the past year has traded below
$2).
[box this]
Losses to date
XM reported a loss of $304m on revenue of $161m through the first three quarters of 2004, after reporting a
loss of $319m on revenue of $92m in 2003.
Sirius reported a loss of $450m on revenue of $41.6m through the first three quarters of 2004, after reporting
a loss of $226m on revenue of $12.9m in 2003.
[Close box]
Bear Stearns’ view is that Sirius’ recent news flow (in particular the Howard Stern signing, then winning the
radio rights to Major League Baseball, and recruiting Viacom’s former boss Mel Karmazin to run the outfit)
wholly confirms their guidance that by far the best way to describe Sirius is akin to Pepsi in its position to
Coke, and not VHS vs BetaMax. It can be a win-win for both brands. In fact, Sirius’ new radio models (and
also XMs spectacular “walkman” device) will help take the whole sector into the mass market. “It remains
clear to us that the reason pay TV (cable or satellite) is so successful (90-95% penetration of US TV
households), is because of its value proposition: more choice (channels) than the terrestrial offering and no
commercials for an appropriate fee. Satellite radio is no different in our minds,” says Peck’s report. “Just as
some investors thought paying for TV back in the 1970s would never work, we’ve had some naysayers
iterate the same thoughts on pay radio. However, we think that the legitimacy that recent partnerships have
brought to satellite radio has many pessimists rethinking their opinions and ultimately trying to gauge where
the satellite radio stocks can go,” adds Peck.
Peck admits that satellite radio has one major difference with DBS/DTH, and it is in radio’s lower ARPU
levels. Consequently, Bear Stearns looks instead at cash flows within the radio sector to get a better feel for
overall profitability. Peck says that typically DBS subscribers churn at a rate of around 1.7% a month (in the
US), and that gives a subscriber ‘life time’ of some 4.75 years. Next, he looks at Echostar’s average ARPU
of about $58 a month, or $696 a year. Then Peck includes into the equation Echostar’s pre-marketing cashflow margins of about 38%, its maintenance capital-expenditure ($18 per sub), Subscriber Acquisition Costs
(SAC) of some $600, press the ‘compute’ button, and Peck says the end result is an internal rate of return of
about 28%, which proves, says Peck, that “DBS is clearly a good business to be in” with cashflows of $246
in a full year (for the typical first 4 years of life, and $180 for the ‘final’ year of the average).
This same model is then applied to Sirius, with much the same churn rate, meaning a similar subscriber
lifetime, but $11 a month in typical ARPU ($132 a year), and an assumption that Sirius “conservatively
reaches a run rate pre-marketing cash flow margin of about $50% to derive an annual pre-marketing cash
flow of about $66 per year,” says Peck. Finally, he assumes a much lower maintenance capex, of $5 a year,
generating an annual cash flow of $61 per sub. Add in SAC of $140 (and predicted to be lower from 2005
onwards) and applying the same formula and Peck suggests Sirius’ internal rate of return is a very nice 32%
(again ignoring taxes) or $61 a year for the first 4 years, and $45 for the average final year.
[box this]
DARS ITEMS OF NOTE
1) MCV is 90-95% penetrated - DARS only 2.5% (4.5M of 200M cars)
2) MCV target market 100M TV households – DARS 300M (cars + households)
3) DBS is dwarfed by cable competition – DARS has no mobile pay competition
4) DBS pays ~40% of revenues for its content – DARS pays ~7-10%
5) DBS is not installed automatically into homes – DARS is in cars
6) MCV is proven (the mass market will pay) – DARS is still nascent
7) DBS will spend ~$2B in capex to handle HDTV – not needed by DARS
8) DBS had limited exclusive content (only NFL) – DARS has Stern, MLB, NBA
Source: Bear, Stearns & Co., Inc.
[close box]
ADVANTAGE?
DARS
DARS
DARS
DARS
DARS
DBS
DARS
DARS
All this is very useful, suggests Peck, but there are positives and negatives that must also be added to the
DARS mix. First up is that Echostar and DirecTV (and not to ignore struggling VOOM) are fighting for a
share of the multichannel TV market that is already 90-95% penetrated. DARS has only 2.5% penetration
and is just starting out on the road, with installations in just 4.5m of the USA’s 200m cars. As the tennis
umpire might decide: “Advantage DARS”. Next, is the size of the multichannel TV market, which is about
100m TVHHs. The potential for DARS is the already mentioned 200m cars, PLUS says Peck the 100m TV
homes. Quite definitely, “Advantage DARS”. Peck says while DBS remains dwarfed by the size of the cable
market, DARS has no mobile pay competition. Moreover, DBS pays typically 40% of its revenue for content
while DARS pays just 7-10%. Worse, DBS is never automatically installed into homes while DARS is now
frequently pre-installed into vehicles. While multichannel TV is a proven concept, DARS must still be
considered nascent “although with much promise”, suggests Peck. DBS also faces a huge bill to convert to
HDTV, while DARS is already digital high fidelity. Finally, DBS has limited exclusive content (compared to
cable and network TV), while DARS is beginning to show it can deliver attractive exclusive content along the
Howard Stern model.
Bear Stearns says the overall advantage is definitely in the DARS court, which simply has “more upside”
than DBS, and this is what persuaded Peck to raise his initial target price for Sirius from $5 to $7.50
although his note was quickly overtaken by events. Peck added that the share price comparison with
Echostar suggests that Sirius, provided it hits a few DISH-like milestones, is a perfectly sensible
comparason and should generate a similar upward growth curve in terms of market price. “Looking back at
the major milestones Echostar has achieved, we think the most significant [result] would be subscribers.
Therefore, we have looked back to see what enterprise value the market assigned to Echostar when it
reached the 2M subscriber milestone. We project Sirius reaching this milestone at the end of next year, and
think it’s reasonable (based on the analysis above) that Sirius could achieve a similar valuation,” says Peck.
But he also modifies Sirius’ Enterprise Value somewhat because Echostar hit its magic numbers back in the
heady days of 1999 with the market foolishness of those days, but nevertheless Peck seemed comfortable
that by the end of 2005 Sirius could be trading at the $7.50 mark. Again, events have shown that price to be
an under-estimate.
Indeed, there’s still more potential upside. So far Peck has kept strictly to the financial numbers. But he then
suggests that even if the much-touted Howard Stern signing doesn’t result in 1.2m incremental subscribers
(needed to make the deal financially worthwhile), Sirius could even permit Stern to be something of a
marginal loss-leader while at the same time helping support Sirius’ other programming, as well as being an
evangelist for the promotion of DARS radio in general. But, says Peck, signing Mel Karmazin (the “Mel”
factor) takes satellite radio to another dimension, adding: “His appointment as CEO clearly heightens the
credibility of the growing satellite radio industry… Karmazin was a good strategic move and increases Sirius’
chances of success on many levels… As the former CEO of Infinity, Westwood One and CBS, Mr.
Karmazin brings to Sirius ~ 35 years of radio operating programming and sales experience. As COO of
Viacom, Mr. Karmazin also gained extensive knowledge of broadcast and cable TV and in negotiating rights
fees, including the NFL. His radio experience and ability to attract, negotiate and sign major programming
rights is a major advantage for Sirius,” says Peck.
Peck’s right. The Karmazin signing takes Sirius up at least a couple of notches. He knows just about
everyone in US network radio. He is a skilled media operator and the market is expecting him to be a major
catalyst in content and personality signings. Clayton stays on board, at least for the time being, although
some voices suggest he’ll then make a move to another start-up.
Promised new services from Sirius include direct-to-unit stock prices, plus “sports scores, and recording
capabilities - and, it'll even lock and unlock your car doors, said Joe Clayton, chairman of the board. Clayton
spoke to investors at the UBS Warburg Media Week Conference at the Grand Hyatt New York before
Christmas. "We're 'tech-agnostic' - we provide service over the Internet and we want to look into iPod
technology," Clayton said, commenting on the growth path the company has charted. "As an entertainment
company, we want to be able to provide our service over as many platforms as possible. And we want to
provide as many different services as possible, such as rear-seat video and even security for your car."
"Currently, our business comes from 25% automotive, 75% retail, and within the near future, those figures
will be inverted," Clayton said. "Among the other services we plan to offer is navigational ability for the car.
One day soon, this will be standard equipment in every vehicle. And it is not inconceivable that by 2015,
we'll have 100 million subscribers via automakers."
[Box this]
The DARS battleground
Share Price
Fully Diluted Shares Out
Market Cap
+ Debt
- Cash
- Cash from Options/Warrants
= Enterprise Value
% of DARS EV
Source: BSC estimates
[close box]
Sirius
$6.51
1,720.1
$11,198
58.9
(843.2)
(765.8)
$9,647.8
46%
XM
$37.61
306.1
$11,513
777.0
(727.5)
(162.6)
$11,400.0
54%
Total
$21,047.9
As for future sales, Bear Stearns suggests that taking the longer view to 2010 it will be DirecTV that will still
be ahead on subs numbers at 19.736m, with Sirius totalling 15.320m, and an Enterprise Value per sub of
$578 for XM and $606 for Sirius. Their combined EV in 2010 should be a tad over $20bn, which – says Peck
– is still only about the same level as Echostar was when it passed the 2m subs milestone. He gives XM a
target valuation of $45, of which more in a moment.
[Box This]
DARS – The subs numbers (‘000 year-end)
2003A 2004A 2005 2006
XM
1,360 3,2
5,516 8,291
Sirius
0,261 1,1
2,020 4,720
Data: Bear Stearns
[Close Box]
2007 2008 2009 2010 2011
11,291 14,166 16,966 19,336 22,401
7,220 10,020 12,620 15,320 15,820
Bear Stearns has also looked in depth at XM again, responding to the recent movement in XM’s stock price,
and asking whether XM’s price had also moved too far, too fast? Using the same methodology applied to
Sirius, Peck comes to the conclusion that the end of 2005 will represent XM’s probable inflection point with
the platform likely to hit a key 5.5m subs number and a corresponding Enterprise Value of $15bn by year
end 2005, or $45 a share. Peck’s not unreasonable view is that the overall newsflow within the DARS sector
is ‘raising all boats’ and at the same time reducing the risk in the business model.
He says the overall share price movement (in the 6 weeks up until the end of November) put XM up some
30% and Sirius up a staggering 76%, all of which helps Peck with his overall vision for the sector. Key to his
thinking is the possibility that satellite radio, as we have mentioned before, will be a ubiquitous addition to
the market. He suggests that as technological advances make improvements in chip functionality and power
demands satellite radio could even find its way onto cell-phones, PDAs and MP3 players. Peck stresses that
the signing to Sirius of Howard Stern and Mel Karmazan is good for the whole sector. “Obviously, Sirius
becomes a more formidable competitor with both on board, but we think all of satellite radio will benefit from
the publicity that both bring to the table. If there is one major takeaway for investors by their signings, it is
that satellite radio is going to be a viable medium with a potential mass-market appeal for a long time. We
also think the signing of Major League Baseball for XM further corroborates this theme and gives a nice
counter punch to Sirius’ exclusive NFL programming,” explains Peck.
DARS satellite radio is also an informal hit North of the Border in Canada. Like the “gray” market in exported
DirecTV and Echostar boxes, there are a growing number of XM and Sirius systems in use in Canada, and
the Canadian authorities don’t much care for it. XM and Sirius both have subsidiaries operating in Canada
pitching to local regulators for permission to legitimately sell their services. They are offering a slice of their
bandwidth to all-Canadian channels, and these channels would also be available in the continental USA.
Japan is also looking at a DARS system, but that’s about it. Despite the rumours, Europe’s efforts are limited
to one failed company (Global Radio) and an embryonic plan to use the ground-spare AmeriStar craft
initially built Worldspace. There were a flurry of announcements back in 2002, but the Worldspace/Alcatel j-v
has since gone quiet since.
There are opinions in Europe that suggest Europe’s multitude of languages, and higher, tighter GEO angles,
would make DARS over Europe a much tougher play. While the USA lies mostly between 49 deg North (its
border with Canada) and 30 deg N, the most densely populated parts of Europe are between 45 deg North
and 55 deg N. Only Spain, Portugal and Italy (and former Yugoslavia and Turkey) are below the 45 deg N
parallel.
There are other problems: North America has just a handful of automotive giants. Europe has dozens of car
builders. North America’s commercial radio options are limited. Europe has hundreds of publicly-funded
radio stations (albeit operating at national levels) as well as commercial operators. America is a market
that’s highly dependent on the car, while Europeans tend to use public transport at much higher levels, for
short as well as longer journeys.
Those challenges remain. However, two years ago Global Radio, the Luxembourg-based embryonic
operator of a proposed pan-European DARS system went bust having failed to achieve second-round
funding. Today’s investment opportunities might be significantly better, especially with the XM and Sirius
experience to hand. It is quite likely that those old business plans are being dusted off for a second look.
3500 wds